A Dozen Things That A Business Lawyer Should Know About The Bankruptcy Abuse Prevention And Consumer Protection Act Of 2005 - Part III

Saturday, April 1, 2006 - 01:00

"One of the prime purposes of the bankruptcy law has beento protect creditors from one another."
- Mr. Justice Black in Young v. Higbee Co., 324 U.S. 204 (1945).

Claims Of Taxing Agencies And Governmental Units

Taxing agencies and other governmental authorities receive more favored treatment.

BAPCPA implements numerous changes in the taxation of debtors and bankruptcy estates under 346 of the Bankruptcy Code. In addition to technical amendments beyond the scope of this summary, the treatment of tax claims has been altered as follows:

  • New 511 provides that interest will accrue on all tax claims at the rate determined under applicable nonbankruptcy law, which is often higher than the federal rate formerly applied to such claims.

  • If the debtor restructures its business and finances through a Chapter 11 plan of reorganization, all priority tax claims must be paid in regular installments in cash, over a period ending no later than five years after the commencement of the case, and in a manner no less favorable than the treatment accorded the most favored class of non-priority unsecured claims (other than "convenience class" claims).

  • The bankruptcy automatic stay will no longer prevent taxing agencies from setting off any tax liability for a period prior to the commencement of the case against a refund payment that would otherwise have been issued postpetition.
  • The amendments also erode the broad discharge of debts traditionally available in Chapter 11. A corporate debtor may no longer discharge any obligation to a domestic governmental unit that would be excepted from the discharge granted to an individual debtor pursuant to 523(a)(2)(A) or (B) (which address property acquired or credit incurred by false statements or actual fraud). This change may encourage governmental units such as the Small Business Administration to litigate dischargeability, a form of dispute formerly prevalent only in individual cases.

  • Consistent with the nondischargeability of debts incurred by fraud, BAPCPA also makes a tax or customs duty nondischargeable if the debtor filed a fraudulent return or willfully attempted to evade or defeat such a tax.
  • Appointment Of A Trustee Or Dismissal Of The Case

    Management misconduct is more likely to result in dismissal or conversion of the case or the appointment of a trustee or examiner.

    Prepetition managers ordinarily remain in control of a corporate debtor in Chapter 11 bankruptcy, subject to court supervision with respect to matters outside the ordinary course of business. Section 1104 describes the conditions under which the court may nonetheless appoint a trustee to operate, or an examiner to investigate, the debtor's business or finances. Most of BAPCPA's changes to this section are relatively minor, but new subsection (e) requires the United States Trustee to seek the appointment of a Chapter 11 trustee if there are "reasonable grounds to suspect" that the debtor's current managers, or members of its board of directors, participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or in the debtor's public reporting.14 Questions raised by this change include the following:

  • Won't the United States Trustee often decide that the politically safe move is to file a motion under 1104(e) if there is any doubt as to the honesty of management? How will the Office of the United States Trustee fund major litigation in connection with this new mandate?

  • Must the fraud be pleaded with particularity? Does 1104(e) trump Rule 9(b) of the Federal Rules of Civil Procedure, incorporated into most bankruptcy disputes pursuant to the Federal Rules of Bankruptcy Procedure?

  • How pervasive must the fraud be to warrant intervention? What if only one board member is involved? Or, what if the current board selected a chief financial officer who engaged in dishonesty but has since left the company?
  • Congress's approach in amending section 1104 is the opposite of that favored by creditors in most substantial cases: an aversion to encumbering the estate with new administration, particularly where there is some confidence in the debtor's legal counsel and other advisors.

    BAPCPA also expands the grounds for a party in interest15 to seek dismissal of a Chapter 11 case, or conversion of such a case to Chapter 7, under 1112 of the Bankruptcy Code. Most such matters were previously left to the court's discretion upon a showing of "cause," elements of which were outlined in a non-exhaustive list. BAPCPA essentially displaces this permissive approach with the word "shall" except in unusual circumstances where the court finds that conversion or dismissal, although justified, is not in the best interests of creditors and the estate.

  • New 1104(a)(3) links sections 1104 and 1112 by permitting the court to order the appointment of a trustee or examiner in lieu of dismissal. (This provision would be better placed in 1112.)

  • Amended 1112 contains an expanded list of what constitutes "cause," which in the case of an individual debtor includes failure to pay any domestic support obligation that comes due during the case.

  • The amendments to 1104 and 1112 appear likely to generate substantial litigation, much of which will be tactical and thus may be viewed by most creditors as a waste of time and money.
  • Pre-Packaged Plans And Extensions Of Plan Exclusivity

    The BAPCPA amendments limit exclusivity extensions and encourage pre-packaged plans.

    One of the most valuable protections afforded a business bankruptcy debtor is the exclusive right to formulate, propose, and solicit support for a plan of reorganization. Once the debtor's exclusivity period expires, any other party in interest may promote a competing plan. The debtor's exclusivity period for proposing a plan nominally terminates 120 days into the case, and the deadline for obtaining acceptance of the debtor's plan arrives 180 days into the case. But under prior law, the exclusivity period could be serially extended "for cause," often for a span of several years, as long as the court could be persuaded that management was making progress toward a plan with a reasonable probability of success.

  • BAPCPA attracted particular comment by limiting such extensions. As amended, section 1121(d) now provides that the debtor's proposal period may not be extended beyond 18 months after commencement of the case, and the acceptance period for the debtor's plan may not be extended beyond 20 months after commencement of the case. This change in itself appears to have prompted a substantial number of business debtors to commence Chapter 11 cases prior to the amendment effective date of October 17, 2005.
  • BAPCPA also makes two important changes to the law governing prepackaged plans, (or "prepacks") in which, before a bankruptcy petition is filed, some of the parties negotiate elements of a proposed reorganization and line up as many creditors as possible to vote in favor of that structure. Because the Bankruptcy Code prescribes the entire plan solicitation process and binds certain dissenting creditors to the terms of a confirmed plan, 1125(b) provides that a party in interest may solicit votes in favor of or against a plan only pursuant to a formal disclosure statement approved by the court.

  • Under new 1125(g), solicitation for a prepack may continue, despite the commencement of a Chapter 11 case and the constraints of 1125(b), as long as the solicitation is in compliance with applicable nonbankruptcy law. This will prevent dissidents from disrupting a prepack by filing an involuntary petition before the solicitation is completed.

  • Further, new 341(e) provides that where acceptances of the debtor's plan were solicited prepetition, a party in interest may seek a court order that the initial meeting of creditors (ordinarily mandated by 341(a)) will not be conducted. This change will also reduce delay in the confirmation of prepackaged plans.
  • The Automatic Stay

    BAPCPA expands the circumstances in which the automatic stay does not apply or is automatically terminated, and modifies procedures for judicial determination.

    Section 362 of the Bankruptcy Code provides that the filing of a bankruptcy petition constitutes an automatic stay that bars most actions to enforce prepetition obligations against the debtor or its property. The statute also identifies exceptions to the stay, conditions under which creditors may obtain relief from the stay, and, under 362(c), conditions under which the stay will be deemed to have terminated.

  • Factual disputes often arise over whether an event has occurred that would trigger an exception to the stay or cause its termination. New 362(j) provides that "the court shall issue an order under subsection (c) confirming that the automatic stay has been terminated." Although this amendment was apparently developed in the consumer context, its wording suggests that it applies in all cases.

  • The debtor's ability to recover damages for violations of the stay under 362(k) (formerly denominated as 362(h)) is now restricted in several respects, including 342(g)(2), as discussed below.16

  • BAPCPA also amends 362 to provide that securities self-regulatory organizations, such as stock exchanges, may continue investigations of debtors with publicly traded securities and may delist the debtor's securities without violating the stay.
  • David A. Honig and Patrick A. Murphy are corporate partners in Winston & Strawn's San Francisco office. Mr. Honig concentrates his practice in bankruptcy matters and related litigation in the telecommunications and technology industries. He can be reached at (415) 591-1423. Mr. Murphy concentrates his practice in corporate reorganizations and insolvency law. He can be reached at (415) 591-1500.

    Editor's note: Parts I and II of this article appeared in the February and March issues of The Metropolitan Corporate Counsel, respectively. Part IV will appear in the May issue.